As an investor, it is necessary to stay on top of economic trends and understand how they impact financial markets. But it is also just as important to recognize the difference in speed with which the economy and financial markets move as well. The economy can be compared to a massive cargo ship or ocean liner - it has tremendous inertia and takes a long time to change direction or speed up/slow down. Economic indicators like GDP growth, employment, and consumer spending move gradually, building up momentum over months or years.
In contrast, the stock market is like a fleet of speedboats escorting the large “economic ship,” swarming alongside and riding the waves created by the larger vessel. However, these speed boats are highly maneuverable and can quickly change direction based on incoming news, investor sentiment, and temporary thunderstorms. Just as share prices can rise or fall rapidly in a matter of hours or seconds.
However, just as a speedboat cannot completely disregard the ocean currents and waves generated by the larger ship, the stock market is highly influenced by the underlying economic conditions and trends. If the ocean liner changes course, the speed boats must navigate accordingly. Of course, the nimble speedboats (stock market) can zip ahead of the lumbering cargo ship (economy) for a while but cannot permanently defy the larger economic currents and waves for very long.
Right now, we believe there are a lot of warning signs pointing to a potential recession within the next 6-12 months. The economic ship is blowing its whistle and slowly changing course. We have talked about these red flags in previous newsletters, and recent data only confirms our thinking. The tricky part is figuring out which indicators are key to predicting immediate market direction and which ones we can ignore. In particular, the labor market stands out as a crucial indicator in our view.
It is hard to have a recession when employment is strong, and people can work and earn a paycheck. For this reason, we ignored all the Wall Street recession predictions last year. However, the labor market is beginning to weaken. At 3.9% unemployment, it is not weak by any stretch. But the employment numbers are starting to change course as evident by the recent unemployment levels provided by the Bureau of Labor Statistics (bls.gov).
April 2024: 6.3 million unemployed
March 2024: 6.2 million unemployed
February 2024: 6.0 million unemployed
January 2024: 6.1 million unemployed
The Piper Sandler Recession Indicator is another red flag that we have added to our list of recession indicators. It is a metric that tracks the three-month moving average of the year-over-year percentage change in the number of unemployed persons in the United States. When this indicator crosses the 10% threshold, it has historically signaled an impending recession. It has accurately predicted the last 11 recessions with a warning within six months after being triggered. It triggered again last month in April.
Short-Term Market Outlook and Strategic Adjustments
Even with numerous economic red flags, our short-term market outlook remains bullish. I believe that when the Fed starts cutting rates, the market will react positively in a "blow-off top" fashion. This temporary surge will continue until the economic ship has turned so much that the market/speed boats will be forced to follow. Our strategy is not about timing the market perfectly. But there are economic conditions that call for an overweight to stocks and there are conditions that call for a more conservative approach. Effective defense can be the best strategy in turbulent times, and as my old college basketball coach likes to say, "defense wins championships.”
Best,
Ryan McMahon
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